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Life insurance (Life Assurance in British English) is a type of insurance. As in all insurance, the insured transfers a risk to the insurer, receiving a policy and paying a premium in exchange. The risk assumed by the insurer is the risk of death of the insured.
There are three parties in a life insurance transaction: the insurer, the insured, and the owner of the policy (policyholder), although the owner and the insured are often the same person. For example, if John Smith buys a policy on his own life, he is both the owner and the insured. But if Mary Smith, his wife, buys a policy on John's life, she is the owner and he is the insured.
Another important person involved is the beneficiary. The beneficiary is the person or persons who will receive the policy proceeds upon the death of the insured. The beneficiary is not a party to the policy, but is designated by the owner, who may change the beneficiary unless the policy has an irrevocable beneficiary designation. With an irrevocable beneficiary, that beneficiary must agree to changes in beneficiary, policy assignment, or borrowing of cash value.
The policy, like all insurance policies, is a legal contract specifying the terms and conditions of the risk assumed. Special provisions apply, including a suicide clause wherein the policy becomes null if the insured commits suicide within a specified time for the policy date (usually two years). Any misrepresentation by the owner or insured on the application is also grounds for nullification. Most contracts have a contestability period, also usually a two-year period; if the insured dies within this period, the insurer has a legal right to contest the claim and request additional information before deciding to either pay or deny the claim for proceeds.
The face amount of the policy is normally the amount paid when the policy matures, although policies can provide for greater or lesser amounts. The policy matures when the insured dies or reaches a specified age. The most common reason to buy a life insurance policy is to protect the financial interests of the owner of the policy in the event of the insured's demise. The insurance proceeds would pay for funeral and other death costs or be invested to provide income replacing the deceased's wages. Other reasons include estate planning and retirement. Because the insured's death will be to the financial betterment of the policy owner, the owner, by law, must have an insurable interest (i.e., a legitimate reason for insuring another persons life.)
The insurer (i.e., life insurance company) prices the policies with an intent to recover claims to be paid and administrative costs, and to make a profit.
The cost of insurance is determined using mortality tables calculated by actuaries. Actuaries are professionals who use actuarial science which is based in mathematics (primarily probability and statistics). Mortality tables are statistically based tables showing average life expectancies. Normally, the only three considerations in a mortality table are the insured's age, gender, and whether they use tobacco. The mortality tables provide a baseline and federal and state guidelines for how much insurance would cost (guideline premiums). In practice, these mortality tables are used in conjunction with the health and family history of the individual applying for a policy in order to determine premiums and insurability. The current mortality table being used by life insurance companies in the United States and their regulators was calculated during the 1980s. There is currently a measure being pushed to update the mortality tables by 2006.
The current mortality table assumes that roughly 2 in 1000 people aged 25 will die during the term of coverage. This number rises roughly quadratically to about 25 in 1000 people for those aged 65. So in a group of one thousand 25 year old males with a $100,000 policy, a life insurance company would have to, at the minimum, collect $200 a year from each of the thousand people to cover the expected claims.
The insurance company receives the premiums from the policy owner and invests them, using the time value of money and compound return principles to create a pool of money from which to invest, pay claims, and finance the insurance company's operations. Despite popular belief, the majority of the money that insurance companies make comes directly from premiums paid, as money gained through investment of premiums will never, in even the most ideal market conditions, vest enough money per year to pay out claims. Rates charged for life insurance are sensitive to the insured's age because statistically, an insured person is more likely to pass away and trigger a claim as they get older.
Since adverse selection can have a negative impact on the financial results of the insurer, the insurer investigates each proposed insured (unless the policy is below a company-established de minimis amount) beginning with the application, which becomes part of the policy. Group Insurance policies are an exception.
This investigation and resulting evaluation of the risk is called underwriting. Health and life style questions are asked, answered, and dutifully recorded. Certain responses by the insured will be given further investigation. Life insurance companies in the United States support The Medical Information Bureau, which is a clearinghouse of medical information on all persons who have ever applied for life insurance. As part of the application, the insurer receives permission to obtain information from the proposed insured's physicians.
Life insurance companies are never required by law to underwrite or to provide coverage on anyone. They alone determine insurability, and some people, for their own health or lifestyle reasons, are uninsurable. The policy can be declined (turned down) or rated. Rating means increasing the premiums to provide for additional risks relative to that particular insured discovered in the underwriting process.
Many companies use four general health categories for those evaluated for a life insurance policy. A proposed insured can move down the scale easily, but moving up the scale is difficult if at all possible. These categories are Preferred Best, Preferred, Standard, and Tobacco. Preferred Best means that the proposed insured has no adverse medical history, are not under medication for any condition, and his family (immediate and extended) have no history of early cancer, diabetes, or other conditions. Preferred is like Preferred Best, but it allows that the proposed insured is currently under medication for the condition and may have some family history. Standard is where most people fall, allowing for everybody who doesn't fall under the previous tiers. Profession, travel, and lifestyle also factor into not only which category the proposed insured falls, but also whether the proposed insured will be denied a policy. For example, a person who would otherwise fall under the Preferred Best category will be denied a policy if he or she is employed in or makes regular travel to a high risk country.
Upon the death of the insured, the insurer will require acceptable proof of death before paying the claim. The normal minimum proof is a death certificate and the insurer's claim form completed, signed, and often notarized. If the insured's death was suspicious and the policy amount warrants it, the insurer may investigate if there is evidence of its legal obligation to pay the claim.
Proceeds from the policy may be paid in a lump sum or paid over time as regular recurring payments for either for the life of a specified person or a specified time period.
One thing that many people find confusing is the specific use of the term "insurance" and the use of "assurance". What are the differences between them?
In general, the term insurance refers to providing cover for an event that might happen while assurance is the provision of cover for an event that is certain to happen.
When a person insures the contents of their home they do so because of events that might happen; fire, theft, flood etc. Insurance is a way of spending a little money to protect against the risk of having to spend a lot of money. The point is, when a person insures their home contents they do so to provide protection against something that might happen. They hope their home will never be burgled, or burn down but they want to ensure they are finacially protected if the worst happens.
When a person insures their life they do so knowing that one day they will die. Therefore a policy that covers death is assured to make a payment. The policy offers assurance on death; even if the policy has prescribed termination date the policy is still assured to pay on death and therefore is an assurance policy. Examples include Term Assurance and Whole of Life Assurance. An accidental death policy is not assured to pay on death as the life insured may not die through an accident, therefore it is an insurance policy.
A policy might also be assured for other reasons. For example an endowment policy is designed to provide a lump sum on maturity. Under certain types of policy the lump sum is guaranteed. Therefore, this may also be called an assurance policy.
The test of whether a policy is assurance or insurance is that with an assurance policy the insured event will definitely occur (at some point) whereas with an insurance policy there is a risk the insured event might occur.
With regard to Whole Life policies, the question is not whether the insured event (in this case death) will occur, but simply when. If the policy has nonforfeiture values (or cash values) then the policy is assured to pay.
During recent years, the distinction between the two terms has become largely blurred. This is principally due to many companies offering both types of policy, and rather than refer to themselves using both insurance and assurance titles, they instead use just the one.
"Most life insurance companies offer a wide range of insurance and investment services for example pension, investment funds, investment bonds, car insurance, home & contents insurance, life assurance, and even loans. Sometimes a life insurance company will call itself a life assurance company but they mean one and the same." |
